Saturday, November 26, 2016

India Seeks a Cash Cow

The Reserve Bank of India posted this notice on November 8:
Government of India vide their Notification no. 2652 dated November 8, 2016 have withdrawn the Legal Tender status of ₹ 500 and ₹ 1,000 denominations of banknotes of the Mahatma Gandhi Series issued by the Reserve Bank of India till November 8, 2016.
This is necessitated to tackle counterfeiting Indian banknotes, to effectively nullify black money hoarded in cash and curb funding of terrorism with fake notes.
Starting from November 10, 2016, members of public/corporates, business firms, societies, trusts, etc., holding these notes can tender them at any office of the Reserve Bank or any bank branch and obtain value thereof by credit into their respective bank accounts.

The government of India was outlawing the use of high denominational bills, comprising of 88% of the monetary value of cash in circulation.

The bills will retain their value until the end of the year, but the only way to use them is by going to the bank and exchanging them for smaller notes, up to a limit of 4,000 rupees (about US$60).People can also deposit them in a bank account and then use a debit card or electronic transfers for purchases.
Lines formed at banks, with people waiting for days, only to find the bank ran out of smaller bills. Some people were reported as having died in line.
Those without bank accounts had no way to make routine transactions. Already impoverished people had to spend their work time waiting to exchange their money. New bills intended to replace the old ones were scarce.
The results spread through the economy. Merchants lost sales because customers couldn’t pay. Some resorted to barter. Media reports suggest restoring normal commerce could take months. Unable to spend or deposit their sackfuls of large bank notes, business owners across the country are paying employees months of salary in advance, ringing up bogus sales and even buying gold they can smuggle overseas to get rid of stashed money or conceal its source.
The assumption is that the economy will contract for the period. Some think the effect will last into 2018.

The latest proposal is to levy close to 60% income tax on unaccounted deposits in banks above a threshold post demonetization of high-denomination currency notes. Concurrently, the Indian government may also impose curbs on domestic holdings of gold as the war against "black money" escalates.

The rationale for this disruptive idea: counterfeiting, corruption and the black market. Estimates show anywhere from 25-40% of India’s economic activity happens off the books. That is a huge underground economy. And, with all such economies, the government doesn't see it can not tax it. Forcing the economy into the banking system may help in the long run. Regulators can make better decisions. Government planning would make more sense. Taxes should go up. (If you believe all that is good.)

Harvard economist Kenneth Rogoff wants to do this here, in the U.S.. He has a new book out called The Curse of Cash. His plan is to eliminate most paper bills--phasing out $100, $50, and $20 bills, which together account for about 97% of the face value of all US dollars in circulation. This would harm tax evaders and those in the underground economy--especially drug dealers. But there is another, academically appealing, reason: Under a negative interest rate policy (NIRP), putting cash in the bank costs the depositor money instead of earning it. You can avoid this simply by holding paper currency… but not if the paper currency doesn’t exist.
These guys just can not leave us alone.

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